Understanding Your Cash Conversion Cycle

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For small businesses, cash flow is one of the most important determinants of business success.  There are many metrics used to monitor cash flow, one of which is the Cash Conversion Cycle (CCC). We coach all of our clients to track CCC as a key metric.

The CCC measures a company’s effectiveness at converting its investment in inventory into cash. The cycle typically involves purchasing inventory inputs on credit (Accounts Payable), selling the inventory through sales on credit (Accounts Receivable), and converting inventory back into cash. The lower the number of days in the CCC, the more effective management is at generating cash flow from the sale of its product or service.

How the Cash Conversion Cycle Is Calculated

The formula is comprised of three figures.
•    Number of “Days Inventory On Hand” (DIO)
•    Number of “Days Sales Ooutstanding” (see article on DSO here)
•    Number of “Days Payable Outstanding” (DPO)

The formula for calculating the Cash Conversion Cycle (CCC) is:

CCC = DIO + DSO – DPO

DIO, DSO and DPO represent the three component stages of the conversion cycle.  For a service company the cycle would only include the DSO and the DPO metrics.

Breaking It Down

Let’s look at each stage of the CCC to understand the relationships:

  1. The DIO stage measures the time (in days) required to turn over one complete inventory.  DIO can be calculated using figures taken from the annual financial statements; Inventory from the balance sheet and Cost of Sales from the income statement. It is calculated as:
    DIO = Inventory /Cost of Sales x 365
    The idea is to minimize the DIO by turning over inventory as quickly as possible. Selling inventory converts the owner’s investment in inventory into Accounts Receivable, or directly into Cash in the case of cash sales at a retail store.
  2. The DSO stage measures the number of days needed to collect the Accounts Receivable. Using the Accounts Receivable figure from the year-end balance sheet and the Net Credit Sales from the annual Income Statement, it is calculated as:
    DSO = Accounts Receivable/Net Credit Sales x 365
    Like DIO, a business owner wants to minimize DSO. DSO measures how quickly the business is able to convert a credit sale into cash.
  3. The DPO stage measures the number of days it takes to pay vendors for the inventory purchased or expenses incurred to deliver your product or services. Using the Accounts Payable figure from the year-end balance sheet and the Cost of Sales from the Annual Income statement, it is calculated as:
    DPO = Accounts Payable/Cost of Sales x 365
    In contrast to the DIO and DSO stages, business owners want to maximize DPO. A business improves its cash position by holding onto cash longer. Cash flow benefits, of course, must be carefully measured against a company’s payment terms with vendors.  Its important to maintain good relationships with your vendors because they help you grow your business.

The Cash Conversion Cycle metric is most useful in comparing a company’s cash flow performance this year against the performance in previous years, or against competitors’ performance.   By monitoring the trends of the CCC metric, you can spot potential cash flow issues before they become a crisis.

Numbers Coach Identifies Opportunities for Improved Cash Flow for Environmental Engineers

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THE COMPANY

In 1996, Scott Pate launched Sierra Piedmont (“SPI”) with a vision to create a superior environmental consulting, site assessment, compliance, and remediation services firm. Since then, SPI has served a wide range of companies from Fortune 100 businesses to regional firms throughout the United States. SPI’s innovative solutions and advice have helped its clients solve their environmental issues.

SITUATION

Pate and SPI’s management team wanted to realize improved cash flow in their day-to-day operations. However, they were not clear on which financial metrics were truly driving the business and needed more meaningful insights beyond the Profit & Loss statement.

SOLUTION: The Numbers Navigator™

SPI hired the Numbers Coach to provide a comprehensive analysis of its financial operations.The Numbers Coach (“NC”) uses its proprietary Numbers Navigator™ tool set to determine the key financial drivers in SPI’s business model. NC gained a further understanding of SPI’s key business issues through a discovery session with management. NC provided Pate and his team with a comprehensive financial report that identified opportunities to drive more cash flow from the business.

RESULTS

Together, NC and SPI determined realistic and actionable strategies to realize improved cash flow quickly. To achieve this goal, NC provided:

  • A 20+ page financial report detailing key drivers in SPI’s business model,
  • A systematic cash flow forecasting model to provide SPI visibility into its future cash flow,
  • “What if” scenarios analyzed to understand the impact of different financial strategies,
  • Establish guiding principles for disciplined cash flow management process
  • A short-term planning tool to ensure resources and cash were allocated appropriately

“Although it sounds cliché, Numbers Coach and the Numbers Navigator™ truly changed our financial life!” explains Pate.  “The fact is, for many years we had little or no ability to perform high level “what-ifs” or projections of cash effects based on pulling different levers in the company.”

“I don’t know of another program quite like this one,” says Pate. “It doesn’t seem boilerplate or ‘canned.’  I think the most benefit is received by using the Navigator in conjunction with Numbers Coaching services to understand how to apply what is revealed by the report to our financial metrics.”

To learn more about Sierra Piedmont, visit www.sierrapiedmont.com

To learn more about the Numbers Coach financial leadership services, click here

How to Spot These 6 Financial Warning Signs and What They Mean

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If you read the headlines of national and local news, it is amazing that so many businesses are seemingly strong one day, and the next they are closing or filing for bankruptcy.

One of the many reasons this happens is that business owners and managers don’t pay attention (or don’t want to acknowledge) the financial warning signs that could have saved them. By the time the financial collapse starts, it’s often too late to change course.

6 Warning Signs You Can Look For

To help you spot these warning signs, here are the 6 financial red flags that we coach our clients to take action against:

  1. [The Most Telling Sign] Cash Holdings and Equity Are Lower Compared to the Previous Periods
    Take a look at your balance sheet and income statement to determine your overall cash holdings and equity (Assets-Liabilities). If your liabilities are higher, ask why.  Negotiate terms to lower credit rates, extend payment terms, etc. Involve other departments to determine how your business can operate more efficiently and cost-effectively. Discuss simple ways to increase revenue without significantly increasing overhead.
  2. Days in Accounts Receivable Increasing
    Many customers are pushing the envelope with their payment terms. Create a process for collecting outstanding receivables, and ratchet it up when customers start paying late. Customers often pay those vendors with strong systems, and delay payment to those suppliers who don’t have solid collections practices. This doesn’t mean that you won’t work with a long-standing customer who asks you for some flexibility. It does mean that you implement smart AR strategies such as late payment fees, outsourced collections help and credit reporting with clear communication and consistency.
  3. Not Enough Cash Flow for Accounts Payable
    Order in smaller quantities of goods/services from your suppliers. Talk to vendors to negotiate extended terms, leveraging your long-standing relationship and good business practices.  Use a credit card with 60-day terms to maximize the number of days to pay (make sure to review your credit card agreement and understand the terms). Search for discounts for paying within terms if your suppliers won’t stretch the terms. These strategies may not impact your cash flow immediately, but they can have an overall impact by improving your bottom line, since you are buying product or services at a lower price. Get a good handle on your inventory, turn rate, spoilage, sales trends, etc. so you actually buy smarter.
  4. Evaluate Profit Margins and Turnover Ratios
    We all know that decreasing profit margins are a bad sign, but they can’t be evaluated alone. Turnover ratios are also an important factor. Remember, mega grocery stores and warehouse clubs have low profit margins, but high turnover ratios that result in adequate net income and, more importantly, reasonable cash flow. The key is to look at both your profit margins and turnover rates together because how they interact will ultimately tell you how much cash has flowed into your bank account.
  5. Indirect Overhead Growing with Increase in Sales
    Take a hard look at operations. Are you running as efficiently as you could be? Are your employees productive or can they take on more responsibilities? There are more costs to adding employees than just salary, benefits and taxes. You have equipment, space, recruiting/training time, etc. for each employee you hire. The goal is to increase sales without increasing your fixed overhead. If you find there is nothing you can do to avoid increasing your fixed costs, you might need to re-evaluate your business strategy to determine how you can raise your profit margins to accommodate for your increase.
  6. Warning Signs Outside Your Business
    Every business should use and review a weekly dashboard that includes many of the warning sign financial metrics listed above: gross profit margin, average daily outstanding AR, inventory turns, days payable outstanding, available line of credit, operating profit margin, etc.  But ultimately, there are other warning signs that may not be on your dashboard.   Below is a story from a business who engaged a trusted advisor for an outside perspective.

 A Real-World Example of Heeding the Warning Signs

“Most people under-emphasize the available line of credit,” says Joe Dresnok, a consultant with Management Horizons. “The perfect storm for a company is a down economy, reduced sales and the inability to reduce overhead. When this happens, a company needs to access their credit lines to get through the tough times, and invest in other avenues to generate revenue.”

But during a slow economy, banks will reduce credit lines. One of Joe’s clients had a $300,000 line of credit, of which they had drawn down 1/3.  Joe and his team recommended the client draw down the rest of the credit line. Within 30 days, the bank came to give the “bad news” that they were reducing the company’s credit line to $100,000. The company was happy to report they had already tapped out all $300,000 of the original credit line. “In essence, they preserved $200,000, which translated to staying power.”  In this case, it was definitely worth the cost of that credit to preserve the line.

Each company has its own specific set of measurements (metrics) to help owners understand what to look out for in their financials. (Here are the 8 essential financial metrics we recommend tracking.)  This will at least give you the chance to prevent your company from embodying a quote from Ernest Hemingway:  When asked how one goes bankrupt, he said “Two ways:  Gradually, and then suddenly.”

Watch for the warning signs!

Head off Financial Stress with a 90-Day Cash Flow Forecast

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Short-term cash flow challenges are very common among small businesses. When a business responds poorly to a cash flow challenge, its ability to continue operations may be jeopardized. Unfortunately, a poor reaction to a cash flow challenge is what often happens.

A common approach is for a business with tight cash flow to monitor its cash balance daily and estimate accounts receivable for the next several weeks. The problem with that approach is that it doesn’t help you as the owner prepare for a cash crunch due to hit four to twelve weeks in the future. That’s why we recommend clients use a 90-day cash flow forecast.

Rolling 90-Day Forecast

The surest way to avoid an unpleasant cash flow surprise is to use a 90-day rolling cash flow forecast. The forecast usually takes the form of an Excel spreadsheet that shows the expected weekly cash receipts and payments. These are presented line by line and tracked weekly.

To create the forecast requires beginning cash balances, estimated cash receipts, estimated payroll and taxes, estimated operating expenses, payments coming due on notes and leases, and lines of credit.

Creating and updating a 90 day cash flow forecast provides numerous benefits:

  • Visibility into your short-term cash needs
  • Financial discipline in measuring your inflows and outflows of your business; i.e., “What gets measured, gets managed.”
  • Insights into your operations and its short-term flow of activities

Estimating Cash Inflows and Outflows

Inflows

Estimating cash receipts for a 13-week period is one of the more difficult components of the model.  Whether your customers pay in a timely manner is typically a function of their own cash flow positions.  Don’t be deterred from making your best estimates, knowing that actual receipts will differ from your estimates. Use recent payment performance of each customer as a guide.

Depending on the number of customers involved, you may want to create a line on the spreadsheet for your largest customers to identify their specific collection pattern independent of the rest of your customers. Alternatively, if your customer base has numerous small customers, you may want to create a separate tab that provides a general pattern of collection from your monthly sales.

Outflows

Payroll and related taxes are generally easier to estimate because for most businesses, the figures may not change much week to week or they change in a predictable manner. Payrolls that include commissions are more difficult to estimate.  One way to estimate commission would be to obtain a historical trend of commission expense as a percent of sales. Then using this percent apply it to the collected sales or billed sales (whichever the commission is based on) subject to commission and put the amount in the period you expect to pay it.

Cash outflows for accounts payable and operating expenses can be easier to forecast.  We recommend laying out the general timing of when you typically pay an expense. For example, office rent is typically due on the 1st of each month.  In this case, you may show the payment as an outflow in the last week of the prior month to ensure the check arrives on the due date.  If you see headwinds ahead in your cash flow, keep your vendors apprised of your ability to pay and reward their patience as best you can.

Stay in Control of Cash Flow

Business conditions change quickly today.  Keeping a tight rein on cash flow is a small business survival skill and the life blood of a company. The 90-day rolling forecast is a good tool that can help you stay in control of your cash flows. For a forecast to be accurate and relevant, it should be monitored on a regular basis and updated with forecast compared to actual. See where the differences occur and adjust your forecasting for any trends that you see. When the forecast is used this way, it becomes a tool for active management of a business’s cash position.

If you need help putting together your forecast, contact us or check out our Cash Flow Tool Kit

What’s the Key Number You Rely On Daily?

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by Bernadette Peters

Key performance indicators can tell us how well we are doing in our businesses.  But sometimes waiting for accounting software data entry and reporting can be too late for us to make important adjustments quickly.

Many businesses rely on key numbers they can access quickly each day to give them an idea of how they are really doing financially. It can take some time to figure out what that metric is, however, once you do, you are much more prepared to make smart business decisions on the fly.

Coffee Shop Looks at 3 Sales Categories

A young coffee shop and wine bar owner was tracking daily revenues to determine the appropriate number of staff to schedule on a shift.  An early mistake they made was to staff only on the basis of revenue. They later learned that transactions were much smaller and the volume was much higher in the mornings, requiring more staff. And although revenues were much stronger in the evening, higher transactions and retail wine sales required less manpower. Now they look at three distinct categories of sales: coffee drinks, retail wine and enter orders. They can get this information at any time through their point of sale system, which is updated instantly as transactions occur.

Management is able to understand peak volume times and days by looking at this data over an extended period of time. From this information they can understand how to better staff their operation to ensure high-quality customer service experience.

Strategy Consulting Firm Drills Deeper

A typical strategy consulting firm would normally review income and expenses after services have been completed and billed.  However, one firm in particular reviews several other numbers to determine how well they are doing and what adjustments to make along the way.

Jeff Pruett, CFO at ATPAC Group, previously worked as the CFO of a marketing strategy consulting company.  He indicated that his former consulting company looked not only at revenue per consultant, but they also determined how to maximize a consultant’s 40-hour work week via revenue per full-time equivalent employee company wide. This allowed management to determine the ideal work force size. 

Jeff also reviewed how much of the consulting pool’s time was spent on billable and productive activities as opposed to “bench” time to understand how consultants are utilized and billed. He also reviewed project contribution margins as part of ongoing analysis of an in-process job to see if the job is getting in to trouble prior to its delivery and whether it’s losing margin.

What are Your Key Daily Numbers?

What are the key daily numbers that are essential to making decisions about your business on the fly?Determining what these numbers are in your particular business might require some help from a professional, but once you do, your management team can be much better prepared to make smart proactive business decisions. It may require measuring numerous metrics for a period of time, sometimes even two years or more, before you can figure out which metric or group of metrics are truly predictive for your business.

Need some guidance in determining these metrics? The Numbers Coach is here to help. Contact us today for a complementary review session of your numbers.

Why Bother with a Financial Plan?

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by Mike Iverson, Numbers Coach

Any competent financial executive will say “a business needs a sound financial plan” to tie the numbers to a business owner’s strategy. But what does that really mean?

Yes, you need a plan. But how you develop the plan will depend on your business objectives. Question #1 should be “Why are you in business?” Your answer may be:

  • “I want a good, stable lifestyle-maintaining business.”
  • “I want to increase my net worth so I can retire early and enjoy the good life.”
  • “I’ll start a ground-breaking business, grow it quickly and sell it so I can move on to the next adventure. I don’t want to get bored!”
  • “I want to create a legacy for my family.”

You might hear yourself in one of the answers above, or maybe you have a unique reason for starting a business. No matter – there are common elements to be explored as you develop your plan, such as sales, marketing, operations, finance, competitors, which products and services to offer, etc.

Create a Plan

I know it sounds like a lot of work. But keep in mind: if you are in business to create a nice income/lifestyle with moderate growth, then you may choose to keep it simple and short. Your financial plan may be just the number of hours at a specified hourly rate that you need to work in order to achieve your goal. Why spend hours on a 40-page plan when two to three pages is enough?

On the other hand, if you plan to grow your business beyond a few people in order to create a net worth exit opportunity or a significant enough business to leave as a legacy to your children, then a more detailed comprehensive plan will be needed. This means the plan should include all of the elements noted above, with enough market data to support your business premise. You’ll need details to specify what exactly it will take to grow your business. Details such as:

  • Monthly financial projections for 12-24 months
  • Annual projections for 3-5 years
  • Assumptions outlined that support projected sales and expenses (pricing, number of clients, new products, marketing initiatives, comparative plans, product costs and more)
  • “What If” scenarios to illustrate the potential ups and downs.

It is easy to think of the plan as the tool. And it is – a well developed plan helps you manage to your expectations. It provides business measures to keep things on track. (Ever hear the old saying, “If you don’t measure it you can’t manage it?”) But often overlooked is the value gained in going through the planning process, whether it’s a simple two page plan or a full-blown book with multiple chapters. The business idea will be refined and honed, and valuable insights achieved.

Ready to Execute

Once the planning process is complete and documented, with a set of financial projections that tie to your vision and help you see what success looks like and what it might cost you in dollars to do it – you’ll be ready to execute your idea! (Don’t forget, however, the plan is dynamic, meaning it will need updating and modifying on a regular basis!)

In the following case study I will illustrate two key elements I have found among successful entrepreneurs who have implemented a planning process:

  1. They start with the end in mind.
  2. Execution, execution, execution…..

Case Study: The Financial Operations Network

I have been fortunate to have been involved with the start-up and launch of a unique business model in my work with a successful serial entrepreneur – Phil Binkow. I have tremendous respect for Phil and his ability to see opportunities and make them happen.

About 10 years ago, Phil had the vision of building a content rich website for financial professionals, specifically in the area of Accounts Payable. Phil produced one of the best business and financial plans that I have seen. He researched his target audience, asking questions about price, content, and their day-to-day challenges. He carefully studied competitors and the industry to find any gaps. He articulated where he felt the business could go and even reached out to competitors as partners.

After reading the plan, I was convinced that here was a business with solid recurring revenue in a niche no one else was serving. We built a comprehensive financial projection which included assumptions for pricing, ramp up of memberships sold, and types of ancillary services and products to sell. The model also helped us understand the potential capital needed to develop and launch the initial site and a future complimentary resource site.

What Determines Success or Failure?

Phil implemented the two key elements in the planning process that I believe can define the difference between success and failure:

  1. He started with the end in mind.
    In other words, he actually has aligned himself with competitors that could ultimately become potential buyers of the Company. Phil knew intuitively that it is better not to go up against the larger, well financed competitors in the industry, but instead, nibble at their Achilles heel with a product or service that they will not pay attention to until its too late. This makes a company a prime acquisition target. He has a game plan for how he would like to exit.
  2. Execution, execution, execution.
    Phil knew his plan had to have the right premise: to solve someone’s problem. But without a solid execution on the part of him and the management team the business would not have taken off. It would still be at the gate announcing its intention to depart.

Now, fast forward to today. Phil successfully exited that business by selling to a strategic buyer and he and his team have started several new business adventures since!

Need some guidance on financial planning for your business? Check out our Financial Planning Tool Kit

The Quest for Capital

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by Michael Iverson

Once upon a (fairly recent) time, a beverage start-up wanted to introduce a brand new product into a local market. The founders funded the company themselves, with help from friends and family. They developed their proof of concept, the packaging, and ran focus groups. They worked hard.

At the same time, they were showing a well-crafted business plan to potential investors. Eventually aligning themselves with a private equity group with similar companies in their portfolio, they were also able to gain management expertise as well. It was a match made in heaven, and all parties were successful.

“The founders understood the process of securing capital financing,” says Mike Iverson, Numbers Coach. “They did it by the book, and it worked out for them.”

The path to obtaining capital financing for any start-up, or even an established business, is not always so clear-cut. And it doesn’t help that creditors have tightened their belts in the past few years. But money is out there and it pays to know exactly what type of capital is best suited for your business.

Here are some capital investment options that you may consider for your business:

  1. Friends and Family – This money is generally in smaller amounts, when a company needs thousands of dollars, but not millions. Terms are favorable because the investors know you and are trying to help. Still, they expect returns slightly north of the stock market.
  2. Angel Investors – Angels will also invest amounts less than $1 million in very early start-ups, or companies unable to get bank financing. “If a CEO can align themselves with an angel with experience in their industry, he or she can take the company to the next level,” says Iverson. Angels, though, usually want a little more involvement in the business, and it just might be more oversight than an entrepreneur is willing to live with. Also, there could be financing terms that specify that the angel gets control of your company if certain milestones are not met. Angel investors are not as prevalent as they were in past years, but they can still be found. “Ask around in your network, ask your banker, and look on the Internet,” says Iverson. Some sites to get you started include:
    http://nationalnetworkofangelinvestors.com
    http://www.angelcapitalassociation.org/
    http://www.angelcapitaleducation.org
  3. Private Equity Groups – These investors use a combination of debt and equity to help a company grow quickly and offer the founder liquidity or an exit plan, if desired. This option is for companies that need $5-7 million. Some groups offer to finance the debt themselves, at a 9 to 13 percent interest rate; others have a relationship with a bank that will provide the loan. These groups want a 25 to 35 percent return on their investment, so they attach warrants, which allow them to convert the debt to equity at some point. Private equity groups are looking for businesses that have cash flow, some positive earnings and have been around for several years. The fast pace and pressure is not for the faint of heart–investors want their returns quickly.
  4. Bank Loans – Banks are not in the business of helping companies grow rapidly. However, if you have seasonal issues or specific equipment purchases that you want to make, banks are a very good option, and pretty much the cheapest way to get money. These loans are for viable, established companies with some earnings.
  5. Small Business Loans – Small Business Investment Companies (SBICs), which are licensed and regulated by the Small Business Administration, are privately owned and managed investment firms that provide venture capital and start-up financing to small businesses, according to the SBA. (www.sba.gov).  “SBA loans provide favorable conditions,” says Amy Carson, senior business development manager with UPS Capital Business Credit, “such as longer terms – up to 25 years for real estate – and equity as low as 10 percent.”
  6. Mezzanine Financing – A combination of debt and equity financing. Basically, investors give money as debt with the option to transfer it to equity in the company if certain milestones aren’t met. One advantage of mezzanine financing is that it’s usually considered equity on the books (rather than debt), so it may be easier for the company to obtain more debt from a bank or other lender.
  7. Venture Capital – For young companies that need $4-5 million and want to grow rapidly, venture capital is a good choice.  VCs usually invest in a proven management team, even if the company itself is less than a year old. VCs want a board seat, they take equity and they will take control of the company if certain milestones aren’t met. In the past, VCs wouldn’t let a founder liquidate any of his money, but in recent years they’ve loosened that rule. These investors are looking for a much bigger return – typically 50-60 percent – because the companies are younger and the risks are higher.
  8. Factoring – A strict factor will lend money based on the amount of accounts receivable coming in on a monthly basis and can help with cash flow. For example, if you have $100 of receivables, they may advance you $80 of that now. When the customer sends the payment, they keep two percent as a payment and pay you the rest. While this is a simple 24% interest rate and similar to the returns expected by private equity investors, the difference is that you are not giving up any ownership in your business.“Banks like tangible assets. We finance the intangibles, the receivables,” says Steven Gold, president of Allied Financial. “Companies can use the money to make payroll, pay vendors, all in lieu of bringing in equity partners, which is the most expensive money.”

The Bottom Line?

The money is out there – but whether or not you’re successful in securing it for your business depends on the path you follow. Says Iverson, “The way a business is capitalized will ultimately predict how fast it will grow.”

Numbers Coach Tip: If you are considering pursuing a bank loan, be sure to check out our Banking Tool Kit to get your financial records ready for review.

Do You Know What This Financial Warning Sign Could Mean For Your Business?

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Owners are often so immersed in the day-to-day details of their businesses that they can’t always see financial warning signs of tough times ahead. If you can’t see the warning signs, you can’t avoid the danger.

At the Numbers Coach, we teach business owners how to spot the warning signs. We closely monitor revenues, receivables and cash flows. These three figures are closely related. Businesses often struggle because of poor cash flow, which usually indicates declining revenues and/or slow collection of business receivables.

12/12 Rate of Change

One of my favorite tools to spot early financial warning signs of potential trouble is a chart called the 12/12 rate of change. During difficult economic conditions, I watch this rate of change closely. If I start to see it slip from 20 percent to 19 or 18 percent, we need to investigate why. If a business continues down that path for too long, the impact will be quite negative.

Let’s take revenues as a simple example. Each month, we calculate total revenues for the past 12 months and we compare it against the same figure for the prior year. Then, we calculate the rate of change from last year to this year. If last year’s 12-month revenue figure is $1 million and this year’s 12-month revenue figure is $1.2 million, we have a 20 percent rate of change. Perhaps you can’t change the revenue figure during tough times, because customers postpone the purchase of your product or service. In that event, it may be possible to lower your expenses and avoid losing money.

The 12/12 rate of change provides a long-term view of your business. It is very useful for spotting changes in a business trend, positive or negative, that have occurred during the past year.

12/12 Rate of Change for Fixed Overhead

To take the analysis a step further, I like to review the 12/12 rate of change for the fixed overhead of a business. It tends to be a leading indicator of future bottom-line results when combined with the 12/12 rate of change for revenues.

Fixed costs are those incurred whether you generate any revenue or not. They include rent and, for many service businesses, staff salaries and benefits.

Let’s imagine a business has a 12/12 rate of change for revenues that shows 5 percent growth. If the 12/12 rate of change for fixed overhead shows 10 percent growth, the business has a problem to address. The business is adding to its fixed overhead at a rate that exceeds top-line revenue growth. That’s a financial warning sign. Because of the long-term nature of the 12/12 rate of change, there is no need for immediate panic. However, if the situation is not remedied, it will pose a threat to the future health of the business.

To investigate further, I look at the trailing 12 months of revenues and fixed overhead expenses – not the rate of change, just gross dollar amounts. Is the revenue increasing or decreasing? We plot points on a graph to develop a clear trend line. We do the same for fixed overhead expenses. If, earlier in the year, you noticed an unhealthy rate of change trend and took corrective action, you can check your progress by reviewing the trailing 12. Using both metrics gives you a better read of the situation you face today.

What type of corrective action can you take? There are several possibilities, including increasing your sales, speeding up your collection cycle, or cutting expenses.  If you are not sure which path is best for your business, contact us for a free consultation.

The Numbers Coach Stitches Together Financial Plan for Fabric Company

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big duck canvas logo

The Company
Big Duck Canvas (“BDC”), founded by Shawn Mitchell, provides high quality fabrics, canvas and threads to both wholesale and retail stores. Their services include customer cut-and-sew fabrics and fabric printing, which adds a customer’s design features to a fabric. BDC distributes its products throughout North America and can be found online at www.bigduckcanvas.com

The Situation
The BDC team wanted to enhance their financial management and reporting. They were looking to create a platform to communicate the company’s key performance indicators (“KPIs”) that drive its financial results and gain a better understanding of their numbers. The BDC team wanted a financial “road map” that could guide them as they made financial decisions regarding strategies for growth.

The Solution: Numbers Coaching
Numbers Coach (“NC”) coaching services was an ideal fit for BDC’s needs. NC developed a financial scorecard focusing on financial drivers that gave the team visibility into the profits and cash flow critical to sustained profitable growth. The scorecard offers an “at a glance” view of results. NC also developed a financial model using its Numbers NavigatorR proprietary software, providing the financial road map for the BDC team to see where they were headed with profits and cash flow. The Numbers NavigatorR provides a rolling forecast, allowing the BDC team to make financial and operational decisions towards the achievement of their goals.

The Results
NC pulled together financial and non-financial data to complete a customized scorecard and a financial model. NC met with the BDC team regularly to review results and provide numbers coaching around the financial results. From the monthly meetings, the BDC team could take actions on activities to improve the company’s bottom line results and implement best practices.

Learn more about our Numbers Coach financial leadership services here

When Should You Prepare Your Exit Strategy? Now!

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by Collette Parker

The blood, sweat, tears, and late nights put into starting up a business will one day culminate in your exit strategy.  Whether you are passing the company to a son or daughter, a partner, or selling to a competitor or larger corporation, the day must come to say goodbye.

It helps to be prepared for that day, and the sooner the better. Ironically, the birth of a new company naturally inspires an exit strategy. To be prepared means to get the highest valuation for your company; to do that, you have to give yourself adequate time and do your homework.

“Start 15 years ago”

First of all, says Numbers Coach Mike Iverson, plan for the sale of a company well before the day you must sell. “Often business owners don’t give themselves enough time. Give yourself a three-to-five-year planning period to lay the groundwork so that your business is functioning at a high level.”

A buyer will wonder why you are selling your business, and will look for any gaps or holes in your business plan and market. Give yourself enough time to find the gaps yourself and fill them as best as you can.

Iverson has worked with business owners in the past that have very thoughtfully gone through the process of selling. They were contacted by other companies who asked, “Have you ever thought of selling your business?” They might answer, “I’m not ready now,” but cultivated those relationships with a specific purpose in mind. They knew that such relationships could result in connecting with a person who could acquire their company, and they understood how prudent it was to develop a business relationship with that individual to learn how they operate.

“Start those relationships early on, even as you start the company – maybe 15 years before you want to exit,” says Iverson. Then you have relationships in place, and the sale becomes a more natural result.


Do Your Homework

The other aspect of preparing to sell a company is making sure the company is ready for you to walk away from it, and still functions properly.

“Someone has to do the financial due diligence,” says Iverson. “You may have to hire someone to help clean things up, such as customer files and HR files. I can’t stress enough how important it is to get all records in order. It will make the process that much quicker.”

If you’re selling to an individual, that is a different process than selling to a public company.

Iverson spent several years at a public company working in mergers and acquisitions, and observed that emerging growth companies under $20 million that sold for higher valuations had good solid records and complete financial information. They closed their financial records on a regular monthly basis and had an accountant on staff who could ensure the information was complete, timely, and correct.

“Not only will the selling process go much smoother, but it can actually increase the value of the business,” says Iverson. “If you go into a business where administration, accounting, and operations are very disorganized, you will likely get limited or incomplete information which will cause you to question if the numbers given to you are correct.”

“Companies that get the best valuation, in my experience,” says Iverson, “are those that have their financial house, their administrative house and their operational house in order. They are the companies that have planned their sale for a period of time, and they have the right theme in place that could help perpetuate their business even without the owner being there.”

Be Ready to Let Go

If you’re going to sell and you are the sole owner, your business has much greater value if you have set it up so when you walk away, there are no hiccups. You should not be the only rainmaker, nor the only person who knows how to make it run.

“Some companies that are worth less than $10 million have an owner that wants to be in every piece of the business and has a strong personality that people equate to the business. That can run the risk of diminishing the value of the business,” says Iverson.

Ultimately, when someone is looking to buy your business, they want to buy an operating business they can run immediately without investing a lot of additional resources. Customer retention is one of the key elements of success, especially when the owner is gone. While some owners or management teams stay in place after a sale to help transition, nine out of ten times the owners will not be there 24 months after the sale.

Letting go is tough for an entrepreneur who has put their full energy and life’s savings into building a vibrant business.  Planning ahead for the day they want to exit will provide better odds that the business will continue in capable hands and make the sale easier for everyone.

If you want to be prepared for selling your business down the road, check out the Numbers Coach M&A Tool Kit

Numbers Coach Helps Education Company Communicate Game Plan to Team Leaders

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About The Company

Green Building Education Services (“GBES”) is a leading educational services firm that provides the number 1 LEED exam prep solution since 2007.  GBES has served over 150,000 customers with comprehensive solutions to help people advance their careers with the sustainability credentials.  Not only does GBES help its customers pass the LEED exam to get their credentials, but it also continues to support them with continuing education credits to keep their credentials active and relevant.  GBES also provides Well AP certification exam prep and continuing education.  (To learn more, visit the GBES Website at www.gbes.com)

The Situation

In 2020 the GBES team wanted to enhance understanding across the organization for their financial results.  They wanted to find a platform that could communicate the company’s key performance indicators (“KPI”) and help educate its team leaders on what drives the company’s financial results.  In addition, the GBES team wanted a road map that could guide them as they made financial decisions impacting their growth strategies.

The Solution: Numbers Coach Leadership and Numbers Navigator Services

The Numbers Coach’s financial leadership services were an ideal fit for GBES.  Numbers Coach Mike Iverson developed a financial scorecard to focus on the financial measurements that drive company profits and cash flow critical to sustained profitable growth.  The scorecard offers the GBES team an “at a glance” view of results. The Numbers Coach developed a financial model from its proprietary software, the Numbers NavigatorR .  The software provides a road map for the GBES team to see where they are positioned with profits and cash flow.  In addition, the software’s rolling financial forecast gives the GBES team a tool to make critical decisions and see where they are headed financially.

 Results

The Numbers Coach pulled together financial and non-financial data to complete a scorecard and financial model.  Each month, the Numbers Coach meets with the GBES team to methodically review results and provide the input and analysis from the Numbers NavigatorR software.  From the monthly financial coaching meetings, the GBES team has been able take actions on activities that improve the company’s bottom line results and get the team to all row in the same direction.

For more information on Green Building Education Services visit www.gbes.com

To learn more about the Numbers Coach services, click here

“Mike has become an important part of our team.  His approach to educating us on our financial results gives our team the right tools to help us understand how to navigate our finances successfully and stay focused on our financial goals.”  

Dean D’Angelo, President

Balance Sheet: The Second Half of Your Financial Story

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by Anne Moore Odell

A balance sheet shows you at a glance the financial health of a company at a specific moment. It illustrates a company’s assets, liabilities, and owners’ equity. Balance sheets help identify how well a company can meet its obligations and if it has room to grow.

Assets can be anything the business owns that has value to the business including cash, money markets, equipment, and accounts receivable. A liability, on the other hand, is a company’s accounts payables and other creditors’ claims.

A company’s balance sheet should be updated at least monthly. Key metrics on the balance sheet such as cash balances, receivables and payables should be monitored on a weekly or even daily basis. Together with income statements, balance sheets are the financial reports that banks, other lenders and investors need in order to know your credit worthiness.

“Business owners look at their balance sheet and their bank accounts and try to connect the dots,” says Mike Iverson, Numbers Coach. “But if you are preparing your income statement on a cash basis what you have in your bank accounts isn’t necessarily the profit you have coming from the income statement.”

Resources and Responsibilities

Assets on the balance sheet are generally listed in order of how easily they can be turned into cash, their “liquidity.” Cash-on-hand is therefore the most liquid of assets. Current assets are assets which could become cash in a year—for example, accounts receivable or inventory. Real estate and other investments, which would take longer to change into cash, are long-term assets and not easily liquidized.

Iverson explains, “A business generally has two key assets central to generating cash flow–accounts receivable and inventory. If you are a services business then accounts receivable is your main short-term cash flow asset. When you offer credit to customers, you have to remember you are really giving your customers an interest free short-term loan. It is the balancing act of making sure your customers pay you on time so you can pay your own bills on time. The longer your customer takes to pay you the more likely you will have difficulty in paying your own bills.”

If your company has inventory, it is another key asset that needs to be carefully managed. “When businesses have inventory, it has generally been paid for and stored in a warehouse,” says Iverson. “The longer inventory sits in the warehouse, the more cash is tied up in this asset and not getting converted into sales and ultimately cash flow. You want to manage your inventory to the lowest level possible and still meet your sales needs.”

On the other side of the balance sheet are liabilities and owner’s equity. These include short-term or current liabilities accounts payable and notes payable which have to be paid in a year or less. Long-term liabilities are ones that will last longer than one year, for example, mortgage notes payable.

Owners’ equity, also called stockholders equity, is the money provided by the business owner and/or investors, plus retained earnings that have been put back in the business. Owner’s equity is a key number your banker looks at to see how much “skin in the game” the business owner has when evaluating credit worthiness.

Working Capital and Balance Sheet Pitfalls

Working capital is one measure used to know a company’s short-term health, and is calculated from information on the balance sheet. Working capital, also known as the “working capital ratio,” is the amount of cash that a company could generate in a short amount of time if necessary. A simple definition of working capital equals current assets minus current liabilities.

“It’s important to understand the quality of your working capital,” says Phil Poovey, a partner with Bridges & Dunn-Rankin, LLP, headquartered in Atlanta, GA. “If you have a lot of old accounts receivable that you aren’t likely to collect, you are fooling yourself to include them as current assets. Likewise, if you have excess inventory levels, you aren’t going to convert them to cash in a reasonable amount of time.”

Positive working capital is when assets outweigh liabilities. When liabilities outweigh assets, a business might have trouble paying its creditors and if cash can’t be found, bankruptcy declared. Comparing the working capital of a business from period to period helps business owners and investors see how effectively it can support sales growth, how efficient collections are and how quickly inventory is turning over.

Checks and Balances

As the economy struggles to right itself, smart businesses are examining their balance sheets with a magnifying glass to make sure they meet their obligations. “Many businesses are naturally adapted,” Poovey says. “Companies are being a lot more careful about whom they extend credit to. They are staying a lot closer to the clients they extend credit to.”

Poovey says that effective accounts receivable departments are not calling a month after a bill is due, but rather calling a week before the bill is due. Because as Poovey says, “a lot of times, the people who are more persistent are the people who get paid first.” It’s been said “the squeaky wheel gets the grease” so don’t be afraid to ask for your money.

It is important to realize that there are two sides to the story about cash and how much you get to keep in your bank account. Your income statement profit tells you how well you are managing your cash flow from operations and your balance sheet tells you how well you are managing your working capital needs—how quickly you are getting paid from your customers, how long you hold inventory, and how quickly you pay your vendors. All of these factors balance each other to let you know whether you have the money to continue growing your business.